An All-Weather Portfolio Using Multiple Asset Classes

"Watch
the costs and the profits will take care of themselves."Andrew Carnegie (1835-1919)

This article is part of a continuing series on
asset allocation, which explores the potential benefits of investing a wide
variety of asset classes beyond simply stocks and bonds. The multiple asset
class approach to investing attempts to minimize the probability of incurring
significant and prolonged portfolio losses.

In the world of investing, Mr. Carnegie might have said, "watch the losses
and the profits will take care of themselves". As mentioned in a timely article
dated December 29, 2006, False
Diversification May Prove Costly In 2007, long bull markets often cause
us to forget about the benefits of true asset class diversification. To illustrate
the concept of false diversification, we studied a hypothetical portfolio made
up of 12 different mutual funds and ETFs, which declined by 42.49% during the
last bear market in U.S. stocks (2000-2002). Considering the S&P 500 declined
by 46.34% in the same period, our hypothetical growth investor did not have
a truly diversified portfolio due to positive investment and asset class correlations.

If one of your primary objectives is to produce positive investment returns
while having a low probability of incurring losses in a reasonable time frame,
you must first understand how different asset classes behave in different economic
and financial market environments. Asset class performance during the 2000-2002
bear market is covered in Upgrading
Your Asset Allocation For 2007.

Figure 1 shows the performance of the dividend-reinvested S&P 500 index
from 1995-2006. When attempting to reduce portfolio volatility, it is helpful
to identify asset classes or hedging strategies which performed well during
the periods of weakness in U.S. stocks (shown by the blue circles below).

Figure 1

Daily price data for specific investments representing the wide variety of
asset classes listed in Figure 2A was collected from January 1, 1995 to December
31, 2006. Based on investment performance in both bull markets for U.S. stocks
(1995-2000 & 2002-2006) and bear markets for U.S. stocks (2000-2002), the
asset classes were separated according to their appeal in economic expansions
(bull markets), economic contractions (bear markets), and special situations.

An asset allocation between the asset classes listed in Figure 2A was developed
which was able to produce positive annual returns every year from 1995-2000.
In oversimplified terms, the asset allocation was built as shown in Figure
3.

Figure 3

The resulting allocation produced the historical results shown in Figure 4.
It should be noted that while this allocation was able to significantly reduce
volatility is was not able to eliminate it. You can see by close examination
of the blue line in Figure 4 that the allocation does exhibit periods of investment
losses as you would expect in any investment program. However, the historical
results are much more appealing than those of the S&P 500 index. While
we will not publish the specific allocation which produced the historical results
in Figure 4, Figure 3 does give you a visual representation of weightings between
each asset class or investment.

Obviously, the next bear market and subsequent bull market in U.S. stocks
will be different from the most recent cycles. The strategy we are building
was developed with a respect for Mark Twain's way of looking at history:
he stated,

"The past does not repeat itself, but it rhymes."

The future will not be exactly the same as the past, but there will be meaningful
similarities. This strategy is based primarily on how asset classes, not individual
stocks, performed under different economic and market conditions. This should
make the results more relevant than if we studied how Microsoft's stock performed
under the same conditions since individual stocks can be influenced by company
specific outcomes (earnings disappointments, fraud, credit ratings, analyst
recommendations, etc).

A common criticism of any study of historical asset class correlations is
to point out that none of us know which asset classes will be the winners in
the future. While that criticism does hold water, many of the asset class correlations
presented here should remain relevant in future economic cycles. For example,
the odds are extremely high that bonds will be more desirable in an environment
where the Federal Reserve is lowering interest rates (the Federal Funds Rate).
Conversely, in the future, the odds are good that bonds will be less attractive
under conditions where the Federal Reserve is raising interest rates. The odds
are also reasonable that commodities will be more attractive in periods of
economic expansion and they will be less attractive in periods of economic
contraction.

Is multiple asset class investing the cure for all your investment worries?
We all know that no such cure exists. However, research shows that there may
be a better way to build a portfolio of investments that offers real diversification
and an opportunity for improved returns. In an effort to better prepare for
2007 and beyond, I recently conducted some extensive research on the potential
benefits of investing in a wide array of asset classes, including some with
low or negative correlations to U.S. stocks. Since the study, Protecting
Your Wealth From Inflation And Investment Losses, is rather lengthy, I
will continue to summarize what the historical numbers tell us in future articles.
While there are several ways to successfully approach the investment markets,
I feel we can all gain some advantage from reviewing how different asset classes
performed in both bull and bear markets. As time permits, I will continue to
expand on these topics in the coming weeks.

Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable
but we cannot attest to its accuracy. Investment recommendations may change
and readers are urged to check with their investment counselors and tax advisors
before making any investment decisions. Opinions expressed in these reports
may change without prior notice. This memorandum is based on information available
to the public. No representation is made that it is accurate or complete. This
memorandum is not an offer to buy or sell or a solicitation of an offer to
buy or sell the securities mentioned. The investments discussed or recommended
in this report may be unsuitable for investors depending on their specific
investment objectives and financial position. Past performance is not necessarily
a guide to future performance. The price or value of the investments to which
this report relates, either directly or indirectly, may fall or rise against
the interest of investors. All prices and yields contained in this report are
subject to change without notice. This information is based on hypothetical
assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES,
EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM
ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money
management firm based in Atlanta, Georgia. CCM helps individual investors and
businesses, large & small; achieve improved investment results via research
and globally diversified investment portfolios. Since we are a fee-based firm,
our only objective is to help you protect and grow your assets. Our long-term,
theme-oriented, buy-and-hold approach allows for portfolio rebalancing from
time to time to adjust to new opportunities or changing market conditions.